There's One Gigantic Force Holding Down Inflation, And It Should Make Everyone Happy

Dr. Ed's Blog In his Q&A last Wednesday, Fed Chairman Ben Bernanke reiterated that he is concerned that inflation may be too low. That along with high unemployment explains why he pledged to maintain "highly accommodative monetary policy for the foreseeable future." The Fed's inflation target is 2%, based on the personal consumption deflator (PCED) excluding food and energy. This core rate was actually down to 1.1% y/y during May from a recent high of 2.0% during March 2012, matching its record low. The core CPI, reported yesterday, was down to 1.6% in June, the lowest since June 2011. Why is this bad? Bernanke is convinced that "low inflation is not good for the economy because very low inflation increases the risks of deflation, which can cause an economy to stagnate. It raises the real cost of investing, and the evidence is that falling and low inflation can be very bad for an economy." He noted that "transitory factors" might explain the recent bout of disinflation, but he didn't provide any details. He said that he expects that inflation will "come back up." But if it doesn't, then "that would be a good reason to remain accommodative and to try to achieve that objective." In a speech on June 28, FRB-SF President John Williams identified one factor that may be temporarily depressing inflation: "This partly reflects temporary factors, such as a decline in Medicare reimbursement prices forced by sequestration." Sure enough, there has been a significant decline in both CPI and PCED inflation measures for medical care. The former fell to 2.1% in June, the lowest since September 1972. Prescription drug prices were unchanged in June. Hospital costs rose 3.5% in June, the lowest since December 1998. Physician fees have been hovering between 2% and 3% recently in the CPI, but have plummeted close to zero in the PCED. Today's Morning Briefing: The Second Mandate. (1) Inflation is below Fed's target. (2) Core PCED inflation at record low. (3) Bernanke says low inflation is not good. (4) CPI's critics say it understates inflation. (5) Weak global growth depressing CPI inflation in advanced economies. (6) Is inflation only a monetary phenomenon? (7) Maybe the Fed isn't the only inflation game in town. (8) Good vs. bad deflation. (9) Disinflation in medical care, used cars, furniture, and airline fares. (10) Tenant rent inflation rising. (11) Focus on market-weight-rated IT. (More for subscribers.)